A mortgage is a loan agreement between a homebuyer and a mortgage lender used to buy the home. In the agreement, the lender has the right to take the property if the borrower fails to repay the loan and interest. When choosing the right loan, many factors will influence things like the loan terms and interest rates.
What are Mortgage Rates?
Mortgage rates are the interest rates incurred on a home loan. Expressed a percentage, interest rates are how much the lender will make from servicing your loan. Monthly mortgage payments include payments on both the interest and principal, with earlier payments going more towards paying off the interest balance.
Interest rates fluctuate day-to-day as the market and economic conditions change, making it likely to increase and decrease throughout your home buying process. Interest rates usually follow the rule of supply and demand. When there is more demand for mortgages, the interest rate increases and vice versa. When there is a strong economy (significant job growth, rising stock prices, etc.) interest rates increase as the Federal Reserve acts to keep the economy stable. When the economy has weakened (rising unemployment, dropping stock prices, etc.) interest rates are more favorable to home buyers.
Interest rates are also affected by the borrower’s financial situation. Credit scores, income, repayment history, down payment, and debts are all factors that can influence what a lender is willing to give you for an interest rate. If your credit profile is excellent, lenders will be more likely to give you lower interest rates as they view you to be a less risky borrower. The opposite is also true. If your credit profile is not as strong, borrowers may give you higher interest rates to compensate for the higher risk of taking you on as a borrower.
Interest rates influence your monthly payment, made up of payments on the interest and principal balance. However, homeowners should also consider additional costs like property taxes, homeowners insurance, and private mortgage insurance (PMI). PMI is an added cost that is incurred when buyers are not able to place a full 20% down payment on the mortgage. The PMI is an added monthly cost until the home buyer has paid enough of their loan off to have 20% equity in the home.
Similar to interest rates, the annual percentage rate or APR is a reflection of how much the borrower is paying back on their home. Unlike the interest rate, APRs include additional costs like discount points, fees, and other charges the borrower is responsible for. This makes the APR a much more accurate measure of how much the borrower is paying back, even though not all charges come every month.
What is a Mortgage Term?
A mortgage term is the number of years that it will take the borrower to pay off their home. Depending on the borrower’s financial situation, there are a variety of loan options available, however, the most common are typically fixed-rate mortgages.
With fixed-rate mortgages, the interest rate on the loan is locked in for its lifetime. The most common loan of this type is the 30-year fixed-rate mortgage, which spreads interest and principal payments over 30 years. Because of the length of the loan, interest rates are typically higher, but the borrower benefits from lower monthly payments. 15-year fixed-rate mortgages are similar in that the same payment is due each month, but because the loan is shorter, interest rates are typically lowered with higher monthly payments. Borrowers can also opt for 10 and 20-year fixed-rate mortgages if they would prefer. These options are best for people who intend to stay in the property long-term or first-time home buyers.
Adjustable-rate or variable-rate mortgages have a fixed rate for the first 5 to 10 years, after which the interest rate adjusts to the current market. While some borrowers choose this option hoping that when their interest rate adjusts the rate will be lower, the interest rate can also rise. For the remaining duration of the loan, the homeowner will be subject to paying interest rates that fluctuate with the market unless they choose to refinance. Adjustable-rate mortgages are generally better suited to those who plan to move out before the fixed period is up.
Government-backed mortgages are usually better for individuals with low credit scores or those unable to pay a full 20% down payment. Government agencies like the Federal Housing Administration (FHA), the Department of Veteran Affairs (VA), and the US Department of Agriculture (USDA) offer loans to qualified borrowers. With FHA loans, down payments can be as low as 3.5% but come with the additional requirement of private mortgage insurance. VA loans are great for active-duty military personnel and veterans looking to purchase a home. These loans do not require a down payment or minimum credit score and origination fees are capped at 1% of the loan amount. USDA loans have been designed as a zero-down payment mortgage for people in rural areas. Low-income borrowers that would not be approved for other home loans can consider this option. Interest rates for USDA loans can be as low as 1%, however, borrowers are required to pay mortgage insurance as they are high-risk borrowers.
Other mortgages like jumbo loans and interest-only loans are suited for borrowers with high credit scores. Jumbo loans are greater than conventional loans, used by wealthy individuals to buy expensive properties. With these loans, the borrowers must have credit scores over 700 and be able to demonstrate their income. Some lenders even ask for documentation that the borrower has enough in their bank account to cover one year of mortgage payments. Interest-only loans are best suited for those who do not intend to remain long in the home and are designed to be short-term. If the buyer chooses to stay longer, they can refinance after the initial fixed-rate period.
How Do I Find the Best Mortgage Rates?
Getting the best mortgage rate is dependent on several factors. If you know you are going to be in the market for a new home soon, it is worth taking a look at your credit to see if there are things you can fix. Do you have late payments you can get caught up with? Do you have existing lines of credit you can pay down? Getting a hold of your credit score early will help lenders give you better rates when you are ready to apply for your mortgage. Mortgage lenders typically give better interest rates to those with better credit profiles as they are seen to be less risky borrowers.
Once you have decided to begin applying for mortgage estimates, getting more than one will help you find the best rate. Different lenders may charge different interest rates or have different requirements for giving you their best one. Typically, borrowers to get more than one rate estimate can save thousands of dollars over the lifetime of their loan. However, many borrowers do not shop around fearing that it will hurt their credit. When submitting applications for mortgage estimates, the credit bureaus have agreed that any within a 30-45 day period will count as one inquiry on the borrower’s credit report as they only lead to one mortgage being taken out.
Borrowers can also use a mortgage broker, an agent who gives the borrower multiple loans offers from different lenders. Unless the borrower has contracted the broker to act as their agent, the broker is not obligated to find the best rates. Brokers typically have an incentive to get you to choose a rate from them as they are compensated by the lender. Mortgage brokers are a good option for getting multiple quotes, but borrowers should also remember that the rates may not be the lowest available. Since both brokers and lenders can keep the difference between the lowest available interest rate and the agreed-upon rate as an “overage,” borrowers should ask for a full breakdown of the offer to see if there are areas that they can negotiate. Borrowers should also ask lenders for a list of all currently available interest rates and if they are offering the lowest daily or weekly rates so that they can know if there are lower rates available.
Shopping around helps buyers ensure that they are getting the best rate on their mortgage so they can pay less in interest throughout the life of their loan.
How Can I Get a Lower Rate?
If after negotiating for the best rate available from a lender, you still want a lower interest rate, discount or mortgage points can help lower the interest rate further. While points can vary between lenders, typically borrowers can buy one point for 1% of the total loan amount. Generally, one point reduces the interest rate by 0.25%. For example, if the interest rate on a mortgage is 3% and the borrower buys one point, the new interest rate would be 2.75%. Buying points is a tradeoff between higher upfront costs and saving money on interest over the lifetime of the loan. Lenders typically let borrowers by up to 4 points, as most states have caps on closing costs that a lender can charge.
However, buying points should be a carefully considered decision. For home buyers that do not plan on spending long in their new home, they would need to determine the breakeven point, which is the cost of points divided by the monthly savings. If they move out before the breakeven point, they would have lost money on the purchase of points. However, if they plan on staying in the home long-term, points can allow homeowners to achieve significant savings over the lifetime of their loan.
Additionally, if the decision is between buying points and putting the full 20% down on a mortgage, the borrower should determine which is the more financially beneficial option. If they chose to put less than 20% in favor of buying points, the borrower would be responsible for paying additional PMI included in the monthly mortgage payment.
Should I Get Preapproved?
Homebuyers will want to consider getting preapproved for a home loan. With a preapproval, borrowers know what lenders are willing to offer in terms of loan amount and rates based on the financial information provided by the borrower. This helps home buyers focus on homes that are within their price range and they know they will be approved for. Preapprovals are as good as cash usually when negotiating with a seller as they can be confident a lender is willing to fund your purchase of their home. This puts you in a more advantageous position than other buyers who may not be able to prove they can buy the home.
Just like getting multiple rate quotes, multiple preapprovals only impact your credit score once if done within a 30-45 day window. To get preapproved, borrowers provide their credit score, recent pay stubs, recent income tax returns, and bank statements to verify their finances. This is the same information that will be required to complete the actual mortgage application, so it is helpful for borrowers to prepare as early as possible.
If you are denied a preapproval, you may want to consider putting a higher down payment on the property or opt for a longer mortgage term to reduce monthly costs. Sometimes, although you have been preapproved, you may be denied the actual mortgage application. This may be because your financial information has changed since you received your preapproval letter or the amount you are requesting has changed. In this case, you can try to reapply with a so-applicant or cosigner to improve the likelihood of being approved.
There are many factors home buyers should consider when starting the home buying process, but being properly prepared can help improve your chances of success. Understanding mortgages begins by understanding interest rates and terms so that you can choose the best option for your financial situation.
Shopping around and getting preapproved for a mortgage can also make the process easier by finding better rates and being more appealing to sellers.
